You Need A Simple, Effective, And Logical Way To Compare Mutual Funds.

So, how do you compare mutual funds?

With so many funds to choose from, it is crucial to have a way to narrow the field and help you choose the best mutual funds.
Even if you use an advisor, it is just plain smart to understand what method he uses to compare mutual funds and make his recommendations to you.

What you will learn here will either reinforce your confidence in your advisor or perhaps cause you to look for a new one.

Regardless, wouldn't you agree that when you obtain understanding you normally also obtain peace of mind.

When you invest your hard earned money, you must understand what you are doing.

Commit yourself to invest only in funds that meet certain criteria that are both logical and that you understand.

Don't worry about not being smart enough to understand investing and how to choose the best mutual funds. You are. You do not have to be a rocket scientist to be able to intelligently compare mutual funds.

Finally, there are some who add excessive layers of complexity to their decision making process. Too much complexity can overpower you, delay you, and often cause you to make the wrong choices.

The best approach is neither too simplistic nor too complex.

Here you will learn a simple, yet logical way to evaluate and compare mutual funds.

Simplicity leads to understanding and understanding leads to good choices and peace of mind.

How do most people compare mutual funds?

Most people compare mutual funds based on just one criteria... past performance.

Funds that have done well attract new investors because people believe that if they have done well in the past, they will do well in the future.

And, how do most investors learn whether a fund has done well or not?

Most people rely on some third party ratings system or list to guide them to the funds they will invest in.

And, one of the most popular rating systems is the Star Ratings provided by Morningstar.

Many studies have shown that nearly all of the new money invested in mutual funds goes into 4-star and 5-star funds. At the same time net withdrawals are typically incurred by all 3-star, 2-star and 1-star funds.

Even if you use an advisor, he likely recommends 4-star and 5-star funds to you. He knows that if he doesn't that you may go to another advisor.

If most everyone uses the Morningstar rating system to compare mutual funds... the question is...

Does it work? Will you experience superior performance by picking 4-star and 5-star funds?

The answer is... not necessarily.

Studies done by the Financial Research Corporation, Strategic Insight Simfund, the Journal of Investment Consulting, and even Morningstar itself have all indicated that... past performance does not indicate future results.

Consider these comments...

Despite the focus on the stars, there is scant evidence that the stars accurately identify future top-performing mutual funds... the results of the study suggest (that) the stars are not useful in identifying future top performers within asset classes.-Journal of Investment Consulting, June 1999

Over-reliance on the stars - that is, considering only four-star and five-star funds - gets in the way of building a sophisticated, global portfolio.-Morningstar Senior Editor Jeff Kelly, June 1996

Probably the single most potentially dangerous action a mutual fund investor can take is to pay attention to "top performance" lists.-John Markese, President, American Association of Individual Investors, February 2000

If you ask us, star ratings are overrated.-Morningstar's Fund Investor, Morningstar's own newsletter, February 1999

Ouch!

This contrasts sharply with the message you get from most mutual fund ads. Consumers are misled to think that the stars are a recommendation. They are not and should not be used as such.

Don't get me wrong, I love Morningstar. Their data is top notch and reliable. I use it constantly. They provide a very valuable service to investors.

Morningstar is not to blame for the misuse of their star rating system.

Rating mutual funds is much more problematic than rating movies or products.

The reason is... a particular movie or a particular product does not change daily. A product or movie will be the same today as it will be next week, next month or next year.

A five star fund today may be a two star fund in the very near future.

To effectively compare mutual funds, you need a methodology that is broader, and more logical, than just chasing after the currently highest rated funds.

Here is a simple and logical way to evaluate and compare mutual funds.

Since there are literally thousands of mutual funds available to choose from. The challenge is to be able to shorten the list and to choose the best mutual funds for your allocation portfolio.

So, here are the primary characteristics that I look at in order to compare mutual funds. This method is neither too simple nor too complex. It is a logical, effective way to compare mutual funds and make good choices.

Relative Performance. Relative performance is a measure of how well a particular fund performed compared to all other similar funds in it's category over a period of time. The question really is...for each period studied, did the fund perform as you would have expected it to perform. And, is that performance acceptable compared to it's peers? You should look for funds that rank in the upper tier of it's category.

Standard Deviation. Standard deviation is a measure of how much a fund's annual return deviates from the fund's average return. In other words, "how much higher" and "how much lower" than it's average return did this funds annual return vary during a specified time period? The idea is to look for funds with lower standard deviations compared to other funds in the same category. The lower the standard deviation, the less stressfull the ride.

Beta. Beta is a measurement of a fund's sensitivity to market changes. It measures a fund's volatility against the volatility of the overall stock market. Comparing the average returns and betas of different funds and fund classes helps you to evaluate both volatility and risk. The smaller the beta, the better.

Management. A mutual fund manager's job is to take the influx of shareholder's money and then decide what stocks, bonds, or other securities to purchase in order to fulfill the fund's objective. As with all things in life, some managers excel over other managers. However, do not choose a fund based solely on the fund managers reputation.

In fact, you should invest only with mutual fund companies that team manage their funds. Look for companies that use the team format and have done so for a number of years. And finally, look at each manager on the team to determine his level and depth of experience.

Fees. All mutual funds, including no load funds, charge a fee. It is called the annual expense ratio and varies from fund to fund. Some funds within a category charge very little. Others within the same category charge substantially more.

Look for funds within the category who's fees are at least average or preferably below average compared to it's peers. Fees are the least important criterion when it comes to choosing mutual funds. Even though lower fees will allow the fund to invest more of your money for you, it does not mean that the fund will produce superior results.

So when it comes to fees, you should consider them last. If you consider them any sooner than last, when scrutinizing funds, you might overlook some outstanding choices.